Donahue v. Draper

• Decision Date: 09 April 1986
• Citation: 491 N.E.2d 260,22 Mass.App.Ct. 30
• Parties: Douglas A. DONAHUE v. Thomas F. DRAPER et al. 1
• Court: Appeals Court of Massachusetts

Page 260

491 N.E.2d 260

22 Mass.App.Ct. 30

Douglas A. DONAHUE v. Thomas F. DRAPER et al. ¹

Appeals Court of Massachusetts Suffolk.

Argued Dec. 9, 1985.

Decided, April 9, 1986.

Carl K. King (Peter S. Brooks, Boston, with him), for defendants.

Paul F. Ware, Jr. (Marie Lefton, Boston, with him), for plaintiff.

KAPLAN, Justice.

Douglas A. Donahue, an equal owner with Thomas F. Draper of Donahue-Draper Corporation (DDC), a "close" corporation, ² sued Draper and others for damages for the commission of sundry breaches of fiduciary duties and breaches of contract associated with or consequent upon his being "frozen out" of the corporation. ³ The case was tried in much detail to a jury from November, 1981, to January, 1982. The jury, responding to special interrogatories, returned answers prevailingly favorable to Donahue. Thereafter the trial judge made supplemental findings, and on June 28, 1983, an amended judgment entered, conforming to the answers and findings. The defendants appeal from parts of the judgment: Draper ⁴ now accepts that some of his actions were in breach of his duties toward Donahue, but he resists that conclusion as to other conduct.

In outline, the course of events, as the jury could have found it, was as follows. Until some time in 1967, Donahue through a sole proprietorship, Douglas A. Donahue Company (DAD), did business as a broker and dealer in scoured wools and noils; ⁵ Draper, through his wholly-owned corporation, Thomas F. Draper Co., Inc. (TFD), was engaged in the branch of the wool trade called top-making. ⁶ In 1967, the two discontinued their own enterprises and founded DDC, to be engaged chiefly in top-making. They contributed equal capital to the company, received equivalent amounts of its stock, and had an understanding between them of equal efforts, rights, and benefits. Draper became the operational, Donahue the financial partner, although there was some crossing over of functions.

By 1978, DDC had very greatly prospered. At that time, Draper was serving as president of DDC, and Donahue as treasurer, and the directors were Draper, Donahue, and Draper's wife Ethel. ⁷ There was a falling out between the partners in April, 1978. Being able to count on Mrs. Draper's vote, Draper had at the time a practical control of DDC. Draper caused Donahue to be dismissed as treasurer of DDC; thereafter he removed Donahue as a trustee of the DDC pension trust, and as a director and officer of W.A. McNeill & Co., Inc. (McNeill Co.), a close corporation two-thirds owned by DDC. Draper cut Donahue's DDC annual salary (as an employee) to $25,000 while taking a salary of $65,000 for himself, and he took to himself other unequal emoluments. He proceeded toward the liquidation of DDC which was formally voted at a meeting of the directors and shareholders on September 20, 1979, with Donahue joining in the vote. During a preceding period, and thereafter during actual liquidation (completed in September, 1980), Draper so acted as to further his purpose of facilitating a transition or transfer of the top-making business from DDC to TFD. The latter company, reactivated on October 1, 1979, within a short time was dealing with former customers of DDC, occupying the old premises, using similar staff and the same telephone number, and so forth. ⁸

To revert to the meeting of September 20, 1979, Donahue then stated that he was not agreeable to a distribution in kind of the stock of McNeill Co. held by DDC; he wanted cash. Thereafter Draper voted the DDC-owned shares of McNeill Co. (Wesley A. McNeill, the one-third owner of the company, joining) to replace Donahue by Ethel Draper as a director of McNeill Co. The directors acted to remove Donahue as an officer and, on behalf of McNeill Co., to waive any first refusal right in respect to the DDC-owned shares. Draper then caused those shares to be distributed to Donahue and himself in equal parts as a feature of the liquidation of DDC. From October, 1979, onward, Draper by agreement with Wesley McNeill received certain benefits from McNeill Co. in alleged breach of his duty toward Donahue, now a minority shareholder of that company.

DDC made annual contributions to a DDC pension trust. Because Draper was eight years older than Donahue, DDC's contributions to the pension fund on Draper's account exceeded those on Donahue's behalf. In respect to any equalization of pension that was required between them upon the breakup of the company, a special complication arose because of a payment of $110,000 that Draper caused DDC to make to the pension trust on September 17, 1979 (for the trust's year 1979-80).

In consequence of the liquidation of DDC, Donahue received some $321,000, evidently as his share of the avails of the net tangible assets. In the present lawsuit, Donahue sought damages for--

Salary and similar inequalities. In response to the question whether in these connections Draper violated his "duty of utmost good faith and loyalty" to Donahue, failing to act "for a legitimate business purpose which could not be achieved through an alternative course of action less harmful" to Donahue, ⁹ the jury answered in Donahue's favor (interrogatory 1 on "Salary"), and some $71,000 was awarded (of which Donahue would recover one-half). This phase of the judgment has been satisfied.

Pension equalization. The jury made two relevant awards here. One, for $239,707 (answers to interrogatory 2 on "Pension"), has been satisfied. A second, for $110,000, of which Donahue would recover one-half (answers to interrogatories 5[iii] [a] & [b] on "Use of Corporate Funds"), is on appeal.

McNeill Co. affair. The jury awarded Donahue $74,368 as damages (answers to interrogatory 3 on "W.A. McNeill & Co. Stock"). This is on appeal.

Goodwill. The jury found a corporate goodwill of $536,750 wrongfully appropriated by Draper (answers to interrogatory 4 on "Goodwill") of which Donahue would be entitled to one-half. This is on appeal.

1. Goodwill. The jury found that DDC had goodwill of the value mentioned as of a date just before April 12, 1978, the date of the quarrel (agreed by the parties to be the proper time for valuation); that Draper took this goodwill for his own use; and that TFD benefited from Draper's misappropriation. Draper argues on the present appeal that there was less or no goodwill to be taken. ¹⁰

(a) Harold Petersen testified as an expert on Donahue's behalf and used a conventional method (and two alternatives) for ascertaining the existence of basic goodwill as well as its amount. We may take it that goodwill is, fundamentally, the value of an enterprise over and above the value of its net tangible assets, cf. Kavanaugh v. Johnson, 290 Mass. 587, 595, 195 N.E. 797 (1935), a value that may derive from the allegiance of customers, prolonged favorable relations with a source of financing, and the like. ¹¹ In the case of an ordinary "public" corporation, one could (as of a relevant date) take the net earnings as they appeared, apply to this figure an appropriate multiple, and from the product subtract the value of the net tangible assets; any positive result would be an indication of the fact, and an idea of the extent, of the company's goodwill. In the case of a "close" corporation, earnings are typically withdrawn by the partners in the form of company-paid premiums for insurance on their lives, enhanced salaries, contributions to pensions, and perhaps various fringe benefits. Thus comes about a need for adjusting or "normalizing" earnings--ascertaining the "true" earnings--in working a formula for determining basic goodwill. See Wilkes v. Springside Nursing Homes, Inc., 370 Mass. 842, 849-850, 353 N.E.2d 657 (1976); Bessette v. Bessette, 385 Mass. 806, 809, 434 N.E.2d 206 (1982); Hallahan v. Haltom Corp., 7 Mass.App.Ct. 68, 70, 385 N.E.2d 1033 (1979); Herwitz, Business Planning 26-27 (1966). Petersen projected normalized net earnings for a year of $397,462; applied a multiplier of 6.4, which he believed appropriate for the kind of business; thus reached a product of $2,543,757; from which he subtracted net tangibles at the time of $968,608, yielding a basic goodwill of about $1,574,000. In the normalization process, Petersen allowed $70,800 for the combined annual salaries of the partners as a business expense of the company; the excess paid to the partners in the form of salary he considered as part of the company earnings. (The $70,800 amount, in particular, Draper criticized, as we note below.)

As to the alternative methods, Petersen offered one that dealt expressly with inflation, and another that projected earning power ahead for ten years. These estimates converged on the $1,574,000 for basic goodwill. ¹² In the end, the jury allowed a goodwill of around one-third of that figure. On the basis of all that was put before them, the jury might have considered (with respect to Petersen's first method) that it would cost something more than $70,800 per year to acquire substitutes for Donahue and Draper; that the suggested multiplier was somewhat too high, etc.

(b) Draper contends that Petersen's testimony should have been struck or in any event that it was so weak as to infect the jury's findings of goodwill. ¹³

There is no doubt that Petersen was properly held qualified to serve as an expert witness--a matter as to which the judge anyway had wide discretion. See Commonwealth v. Dawn, 302 Mass. 255, 258-259, 19 N.E.2d 315 (1939); Arena v. John P. Squire Co., 321 Mass. 423, 425, 73 N.E.2d 836 (1947); Keating v. Duxbury Housing Authy., 11 Mass.App.Ct. 934, 416 N.E.2d 553 (1981). It may be noted that Petersen had a doctoral degree in economics from Brown University, was an associate professor of economics at Boston College, and had served as chairman of the economics department there. He had a special interest in capital theory and finance. He had had some occasion to study the wool industry before being retained in the present case. He had studied...